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:: Confidence in new Canada Pension Plan is growing despite billion dollar losses
:: Despite recently announcing losses in excess of $1 billion, I believe confidence in the Canada Pension Plan has increased since the plan was converted from a “pay-as-you-go” plan to a “self-funded” plan some five years or so ago. Prior to this change, CPP premiums in excess of a two-year reserve went straight into that federal government slush fund, general revenue, where they were spent, who knows? In its reincarnation as a self-funded plan, CPP premiums are actually accumulated and invested on behalf of those who contributed to the plan, namely you and I what a novel idea. This week I’ll review a tax-saving strategy for those fortunate enough to be on the right side of CPP the receiving end. Next week I’ll look at some issues to think about in deciding when to start collecting benefits.
To provide some background, CPP was introduced in 1966. With very few exceptions, every person in Canada over the age of 18 who earns a salary must pay into the Canada Pension Plan. If you’re an employee, you and your employer each pay half of the required contributions to the plan. Self-employed participants, having no one else with whom to share the cost, must pay both portions. Notice that participation in the plan is mandatory you cannot choose to opt into or out of CPP.
Up until 1992 CPP contributions weren’t particularly onerous, however, since that time CPP premiums have continued to escalate. For example, back in 1995 the employee’s contribution was calculated at 2.7 per cent of pensionable earnings to a maximum of $850.50 ($1,701.00 for both employee and employer share); in 2003, the employee’s contribution rate now stands at 4.95 per cent of pensionable earnings to a maximum of $1,801.80 ($3,603.60 combined employee and employer).
On the payout side of the equation, how much you ultimately receive in CPP benefits is a function of how much and for how long you contributed to the plan after age 18 (or January 1966 when the plan began) and age 70 (or earlier if you start collecting before age 70). To provide an element of protection against the negative impact of low earning years, the formula used to calculate benefits drops out 15 per cent of the lowest earning years during the contributory period.
As to the monthly benefit one can expect from CPP, once a year HRDC sends out a Statement of Contributions that shows, by year, the total amount of your Canada Pension Plan contributions, and your "pensionable" earnings on which they are based. If you are over age 30, this statement will also reflect an estimate of what your monthly pension would be if you were eligible here and now. In 2002 the maximum monthly benefit was $788.75 ($9,465 per annum) clearly not enough to live on but it’s not chicken feed either.
Of course CPP benefits received must be included in the calculation of taxable income, however, one of the unique things about CPP is the government-sanctioned ability to split income with a spouse. Yes, that’s correct, the Income Tax Act contains myriad rules to prohibit income splitting and here you have section 65.1 of the Canada Pension Plan Act giving you the green light to go ahead and do it go figure. Actually, the sharing of CPP benefits isn’t called income-splitting but, rather, HRDC uses the less contentious term, “assignment”. No matter what the term, the effect of assignment is a form of income-splitting.
Assignment is available to spouses who are at least 60 years of age and in a continuing marriage or partners in a common-law relationship, who may apply to receive an equal share of the retirement pension or pensions earned during the years they were together. If only one spouse or common-law partner has contributed to the CPP, the assignment provision can still be used and, indeed, this is the situation where assignment is often most beneficial.
For example, consider a couple that have been married since 1965. One spouse worked outside of the home earning a CPP entitlement of $600 per month; the other spouse has no CPP entitlement. An application for assignment will result in each spouse receiving a monthly benefit of $300.
Notice that assignment does not increase the amount of CPP benefits paid. What assignment does is split, or share, CPP benefits between spouses. Note too that assignment works by splitting CPP benefits of both spouses and not just the applicant.
The amount that can be assigned depends on how long the spouses have been together and the number of contributory periods. HRDC provides the following example:
Mary and Peter have been living together since 1984. Peter receives a monthly retirement pension of $400. He earned $100 of pension before he and Mary began living together and the other $300 after their relationship began. Mary's monthly retirement pension is $550. She was not in the paid labour force prior to her relationship with Peter. During their lives together, Mary and Peter earned a total pension amount of $850. One half of this amount is $425.
Peter submitted an assignment application. Once the application is approved, Peter will receive $100 that he earned prior to his relationship with Mary plus $425 for a total of $525. Mary will receive $425 each month.
Where both spouses are receiving more or less the same monthly CPP benefit, assignment will accomplish very little. The same is true where both spouses are in the same tax bracket yet receiving substantially different CPP benefits. So assigning CPP benefits doesn’t produce results for everyone, but where both spouses are over age 65 a review of their particular circumstances is a worthwhile exercise. Contact HRDC if assignment works for you.
Free Tax Advice Article Submitted to Income Tax Canada.net exclusively by Jim Maroney
Official details about this and other topics on income taxes can be found in English & Francais at www.ccra-adrc.gc.ca
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